Climate change has been at the forefront of most discussions over the past 5 years due to its impact on the environment and on people. However, we commonly overlook the effects of this change on businesses, their finances and solvency.
The above entails the “physical risks” caused by climate change on the financial stability of economies and the solvency of businesses. These risks, by definition, are the possibility that the economic costs of the increasing severity and frequency of climate-change-related extreme weather events, as well as more gradual changes in climate, might erode the value of financial assets, and/or increase liabilities.[1] This fall in the value of financial assets could cause losses for banks, owners, and other financial institutions for several reasons. One such reason would be a growing uncertainty about the future payoffs of financial assets. There is also a growing possibility of credit risks both from the reduction in income (and thus profitability) of borrowers as well as the reduction of value of assets that are used as collateral.
In 2019, the Pacific Gas and Electric company, one of the leading service providers in the world filed for bankruptcy. This move came after the wildfires that ravaged the American west in 2017, where it was alleged that one of PG&E’s faulty power lines sparked a devastating fire. What was an estimated loss of 2.5 billion dollars was soon turned to 30 billion dollars in fire liabilities. This may have been the first recorded bankruptcy caused by climate change, but it certainly will not be the last.
Unpredictable weather changes such as sudden heat or heavy rain negatively affect the supply of natural resources to companies, resources which are essential to the production of goods and services. As these resources become increasingly scarce, firms are forced to either raise their prices to combat the increased cost of production, or to stop production altogether.
In more extreme cases, floods, droughts, hurricane and fires can damage company equipment and harm employees. Here, such companies must divert their resources into rebuilding damaged infrastructure to recover, which is a tedious and costly process that requires years before it can make a profit. Rising sea levels are another one of the biggest threats to the supply chain, obstructing the normal functioning of ports, railway lines and highways.
India was the 7th worst hit countries because of monsoon which is between June to September. In 2019, the monsoon conditions continued for a month longer than usual, with the surplus of rain causing major hardship. Over 11.8 million people were affected by the intense monsoon season with an economic damage estimated to be USD 10 billion.[2]
Today, such supply chain failures are becoming increasingly common. When Thailand experienced floods in 2011, it had severe effects on over 14,000 companies all over the world, with an overall cost of around 15-20 billion dollars. For example, prominent IT company HP lost an estimated 2 billion dollars, Western Digital lost 45% of its shipments and NEC laid off around 10,000 workers due to hard drive shortages. In Japan, Hitachi Limited stated that flooding and excessive rains in southeast Asia posed one of the biggest threats to suppliers. In Brazil, banks such as Banco Santander Brasil have warned against droughts and how they may make repayments of loans by customers more difficult. In London, USA, China and Germany, companies like Alphabet Inc are struggling to maintain their data centers that operate at specific temperatures. These companies are spending more on their cooling processes to ensure that data isn’t lost, however, the problem that prevails here is that such centers simple were not made to withstand the high temperatures that are continuing to rise.
Brands today are also susceptible to “liability risks” these risks occur when brands are held responsible for environmental damage on the claim that it was caused by their negligence or decisions. Pacific Gas & Electrical as mentioned above is one such example. Oil companies like Chevron Corp and Exxon Mobile Corp[3] are facing multiple lawsuits that have escalated to the federal court, by states such as Rhode Island[4], Maryland and California who say that not only have they been deceptive about the impact that their companies have on climate change, but that they have also been avoiding lawsuits for years since they were filed in 2017. These high litigation costs may exceed a firm’s budget, force them into debt and thus, increase the risk of insolvency.
While it is ideal for a business that faces this kind of criticism to make greener choices going forward, by modifying their processes to be less harmful or by buying new capital altogether, such choices then expose them to transition risks. Transition risks are such risks that businesses face following societal and economic shifts to a low-carbon, and more environmentally friendly future. These risks can be in the form of radical changes in policy following significant natural disasters like floods or droughts, where businesses are forced to change their procedures by securing expensive capital or shut down operations entirely. In such cases, the combination of physical and transition risks can have an extremely destabilizing effect on the financial system of such companies. Businesses might also experience a fall in investment as investors become unwilling to fund and support them for being both infamous for their negative impact as well as having capital that could be destroyed by inevitable climate disasters.
Overall, the rapid degeneration of the environment and climate has, and will continue to increase solvency risks for businesses, and financial instability for economies. A report by the “Nature Climate Change” journal showed that the risks of global warming, if left unchecked could “cost the world’s financial sector between 1.7 trillion dollars to 24.2 trillion dollars in net present value terms.”[5] In Asia specifically, by the year 2050, upto 4.7 billion dollars of the GDP could be at risk as people are unable to work long hours outdoors due to rising temperatures.[6]
It is apparent, then, that climate change needs to take the center stage in all business discussions as it is a reality that we cannot look away or move away from. Its impact will only grow, and it will exacerbate company performance. However, there is hope even in these dire circumstances. While increased activism, litigation, destruction of property and loss of investors may look difficult, it can also be considered an opportunity for companies to understand these risks, and proactively prepare for them. Traditional models, from sourcing to supply chain, production to waste management, are unlikely to address them.
Disaster management strategies can play a key role in increasing resilience to certain risks. As part of the global targets, the Sendai Framework[7] helps countries with disaster reduction strategies. In an estimate 40 out of 195 countries of the Sendai Framework have achieved this so far.
Due to Covid-19 pandemic, international climate policy agenda is also affected. Further the Race to Resilience campaign by the Climate Ambition Summit also aims to catalyze a significant change in global ambition for climate resilience and further aims that by 2030 the non-state actors builds the resilience of four billion people from groups and communities, which are vulnerable to climate risks.
1 The implications of climate change for financial stability – FSB. (2020, November 23). Retrieved August
10, 2022, from https://www.fsb.org/wp-content/uploads/P231120.pdf
2 AON 2019b
3 City of Hoboken v. Chevron Corp & Ors. No. 21-2728, US Court of Appeals
4 Rhode Island v. Chevron Corp – 393 F. Supp. 3d 142 (D.R.I 2019)
5 Plumer, B. (2019, June 4). Companies see climate change hitting their bottom lines in the next 5 years. The New York Times. Retrieved August 10, 2022, from https://www.nytimes.com/2019/06/04/climate/companies-climate-change-financial-impact.html
6 Woetzel, J., Tonby, O., Krishnan, M., Yamada, Y., Sengupta, S., Pinner, D., Fakhrutdinov, R., & Watanabe, T.
(2021, June 24). Climate risk and response in Asia. McKinsey & Company. Retrieved August 10, 2022, from
https://www.mckinsey.com/business-functions/sustainability/our-insights/climate-risk-and-response-in-asia
7 The Sendai Foundation aims to achieve the substantial reduction of disaster risk and losses in livelihood and health in the economic, physical, social, cultural and environmental assets of persons, businesses, communities, countries.
